Thursday, May 26, 2005

Near-fraudulent marketing of "Islamic Hedge Funds"

On 28 October 2004, Mr. Yusuf Talal DeLorenzo (identified as "Shariah Supervisor and Director, Yasaar Ltd., London, and Executive Representative to the Shariah Board of the Shariah Equity Opportunity Fund Ltd.") wrote a thinly veiled advertisement piece for the "Islamic hedge fund" that retains his services. In that article/ad, published on Zawya.com, he wrote:

In the hedge fund industry, the preservation of capital is rule number one. It is unfortunate that many people have the impression that hedge funds are about speculation and wild rides on Wall Street. Nothing could be further from the truth. The fundamental principle of hedge funds is that every trade, every move is calculated to preserve capital. The name itself, hedge, is indicative of this fundamental principle. (The Arabic word for the same, tahawwut, is equally indicative of this fact.) In most cases, there is more risk in an ordinary mutual fund than in any hedge fund. For most hedge funds, slow and steady wins the race. Typically, however, it is not the slow and steady horses that catch the eye of the public! Finally, the true nature of a hedge fund is to protect against gambling and speculation, even when others in the marketplace are doing so. So, to equate hedging with gharar is clearly a mistake.

At first, I assumed that this verbal confusion of "hege fund" vs. "hedging" was a function of Mr. Delorenzo's limited financial sophistication. However, I was surprised at a conference in Manama, Bahrain, when Dr. M. Daud Bakar, also retained by the "Islamic hedge fund", continued to play on this verbal confusion. I was on the same panel, and tried repeatedly to explain that while hedge funds have their place in the portfolios of high net worth individuals and institutional investors, they must be understood for what they are: high-risk high-return vehicles that rely on leverage to produce high expected returns. However, Dr. Bakar continued to claim that "hedge funds" are hedging mechanisms. To my surprise, one member of the audience (who represented some investors) said afterwards that he was confused by my remarks: "How could hedge funds be about anything other than hedging?", he asked. Given the repeated attempt to explain the reality of hedge funds, and the repeated insistance on confusing the issue by "Shari`a scholars", I have no choice but to suspect that this is a case of willful fraudulent advertisement to unsophisticated investors: something that would not be tolerated in the developed world.

Interestingly, I also saw a presentation in Istanbul by the actual provider of this hedge fund, Mr. Eric Meyer. He was more careful not to say anything that could get him into legal trouble. However, he did manage to show a slide that claimed historical "higher returns with lower risk". Of course, he did not point out the well-documented reporting/selectivity bias in hedge fund returns and risks (those that fail are dropped from the sample). For more information on this and related issues, see my presentation at the aforementioned Bahrain conference: "Hedge funds: Regulatory (including Shari`a) issues".